ANOTHER LARGE BLACK HOLE: PART I

How much do China’s unfunded pension and other social security obligations amount to? Nobody knows, not even the technocrats in Beijing. There is, however, one thing that’s clear: The nonpayment of pension and other welfare benefits is an explosive social issue. Tens of thousands of workers took to the streets across the country in March and April of this year to demand payments. They remind us that this is no academic problem.

The People’s Republic is an “excellent example of a low information environment.” And that country excels in hiding information about its social welfare obligations. “China seems to have an economy bursting with ‘black holes,'” writes South China Morning Post columnist Simon Pritchard. As the world has learned by now, the extent of these unfunded obligations is one of them.

Let’s begin with what we know. Many workers today are entitled to pensions and other benefits, but they only have a claim against their “work unit,” the term for “employer” in the Chinese Communist dictionary. As a result, some do not receive anything because their work units are insolvent or no longer functioning. Beijing is trying to remedy the problem, and in the process build a more modern economy, by transferring pension and social security obligations from enterprises to the state. During the last decade the central government has been slowly putting into place a nationwide system for workers (though peasants, some 900 million of them, are almost entirely excluded).

THREE FUNDAMENTAL POLICIES
Generally speaking, Beijing has conceived a sound system. For starters, there are the “two guarantees” adopted in 1998: a guarantee of basic livelihood for “laid-offs” and a guarantee of pensions for retirees. In practice, the first boils down to three policies: initial living allowances for up to three years, unemployment insurance for up to two years and a minimum living allowance for all urban residents.

State media tells us that this structure is in place, but that’s true only in the most general sense.

Essentially the country is in a “pay as you go” mode, making pension and other social security payments from current receipts. There are notional accounts for individual workers, but they are not funded. Current retirees are paid from contributions from current employees. Today, the central and even some local governments are bailing out bankrupt local pension pools. Beijing has allocated US$13.3 billion in the past three years to fund pensions and subsidies for laid-off workers. In 2001 the central government chipped in US$3.7 billion. This year it has budgeted another US$6.2 billion.

Although the central government underplays the dimensions of the problems, it nonetheless admits that the funding deficit is increasing at a fast clip. Because the current system is not financially sustainable, it has become clear, as one pension specialist has said, that “non-reform is not an option.” Some analysts use harsher language: “China’s pay-as-you-go pension system, created in 1995, is on the verge of bankruptcy,” says consulting firm McKinsey. Problems plague the plan: Solvent employers do not pay, officials embezzle and employees are being laid off. It is reform already off the rails.

TRIAL RUN
Last year, to get things back on track, the central government opted to test its concepts in a three-year experiment in Liaoning Province. In the words of Finance Minister Xiang Huaicheng, “Liaoning and other provinces are prudently promoting experimentation with the reform to improve the social security system.” These bland words underplay the significance of the experiment in the heart of China’s rust belt. If the technocrats can get it right here, the hardest place in the country to implement their ideas, they can make the social security system work anywhere. Once they get the plan to work everywhere, China should be able to solve its massive state-owned enterprise problem. Officials will not have to worry about social unrest as they go about restructuring the state sector.

And how is the Liaoning experiment doing these days? Just fine if you listen to senior officials. “The trials to improve the social security system in Liaoning and other provinces proceeded smoothly,” says Zeng Peiyan as he delivered his work report to the National People’s Congress this March. The minister in charge of the powerful State Development Planning Commission should know what he is talking about.

Maybe he does, but almost everyone in the world disagrees with him. Among the not so optimistic is the governor of Liaoning Province, Bo Xilai. Bo, after the first year of the experiment, admitted this March that the plan is faltering. Maybe the central government chose to conduct the experiment in Liaoning because he is, in the words of BusinessWeek, “widely regarded as a masterful administrator.” Even if the governor is the best administrator in the world or even in world history, he will be hard pressed to make the central government’s plan work.

For one thing, Liaoning is struggling to find the money to fund its financial obligations. The province paid less than one-twelfth of the pensions that it should have (Rmb1.6 billion instead of Rmb20 billion). Most employers failed to meet their required contributions. “The scheme is grossly underfunded,” said the influential South China Morning Post. “The pressure on Mr. Bo is awesome.”

BEIJING’S LULLABY
Beijing officials, taking a long view, say that the funding deficiencies are manageable because the central government can make up the shortfalls with payments out of current revenues and that eventually employer and employee contributions will solve the problem. That sounds reasonable as a general matter. Moreover, statistics produced in China do not frighten. They tell us that the deficit in the system for the current five-year plan will be US$35.4 billion, and the total cost for the clean-up will be between US$122 to 244 billion.

Those numbers, though they may sound large, are well off the mark. In the middle of the last decade observers widely quoted a World Bank study concluding that funding arrears were in the neighborhood of half of GDP. A better assessment comes from a World Bank expert, who estimates that in 2000 the implicit social security debt was about 71 percent of GDP. Bank of China International, Bank of China’s investment banking operation, estimated in early 2001 that unfunded obligations were about US$850 billion or almost 80 percent of GDP at that time.

As large as all these figures sound, they may underestimate the dimensions of the problem. There exist even higher estimates. A number often used these days is US$1 trillion, which is almost equal to current claimed GDP. And a few years ago pension fund experts in China said that Asian Development Bank personnel were privately guessing the cost to be as high as 100 to 125 percent of GDP.

COLD HARD NUMBERS
What is the true figure? We can see that the funding problem has either grown worse or perceptions have become darker as experts rethink their views. Estimates of social security liabilities resemble that of analyses of nonperforming loans in the state banks: As time passes observers come up with bigger and bigger numbers.

Although no one knows for sure, we should assume that unfunded obligations (pensions, unemployment insurance, guaranteed living allowances, and so on) are no less than US$1 trillion. The most important reason for adopting a number at the higher end of the range is the upcoming wave of layoffs in the state sector. Almost all commentators have underestimated the effect that accession to the World Trade Organization will have on state-owned enterprises.

Today, after the worker protests of this year, the central government talks about the jobs situation as “grim.” The arithmetic of Wang Dongjin, vice minister of Labor and Social Security, is depressing. At current growth rates, the country can generate eight million urban jobs he says. Now, however, there is an “unprecedented” number of new entrants to the workforce: 12 to 13 million a year. Add the number of 5 million laid-off from state enterprises and the 6.8 million registered jobless, and there is a gap of large proportions. And this situation is not helped by the army of 150 million peasants roaming the country for work. As large as these numbers are, they do not measure unemployment in the countryside. State media tells us that the state has made “remarkable progress” in creating employment, but that only underscores how much more remarkable its efforts must be in the future.

The situation is probably worse than Wang Dongjin lets on because he is using official numbers showing urban unemployment at 3.6 percent while unofficial estimates go as high as 30 percent. As the economy slows and as WTO forces wrenching changes in the labor market, the numbers of unemployed can only swell. Moreover, Wang tells us that many of those who have lost their jobs do not have the skills needed in today’s China. The implication is that they will never find steady work again.

Beijing has just published a white paper that pledges to keep unemployment low, but there are few specifics offered to achieve that goal. Even if officials get it right this time, it will take years for their policies to have effect. Yet China’s social welfare problems need to be fixed now.

[Coming Soon: The social security system has just a few months left before it runs out of funds.]

Gordon G. Chang is the author of The Coming Collapse of China, published by Random House.